Limited Liability Partnership: What Is an LLP and How to Form One

What Is a Limited Liability Partnership (LLP)?

A limited liability partnership is a business entity structure in which each partner is shielded from personal liability for the business’s debts and obligations. Partners can manage the company together, but are protected from personal liability for the actions or negligence of other partners.

When forming a new business, there are lots of legal requirements that you’ll have to comply with, some of which might require the help of online legal services. Deciding what type of business entity to start is one of the important legal decisions. Partnerships are a common option for businesses with multiple owners.

Limited liability partnerships (LLPs) can be an especially good choice because they offer legal protections that ordinary partnerships don’t afford. LLPs are particularly common about professional businesses, such as architecture firms, law firms, and accounting firms. Read on to learn more about how limited liability partnerships work, and how to form a limited liability partnership as a small business owner.

How a Limited Liability Partnership Works

The best way to understand a limited liability partnership is to see how it compares to other types of partnerships. If your business is run by two or more people, and you don’t register with the state, by default you have a general partnership.

In a general partnership, all partners manage the business together and are equally liable. Every partner is fully, personally liable for the debts and obligations of the business and for the actions of every other partner. For instance, say Sandy and Jeff run a gardening partnership together. If Sandy damages a customer’s lawn, the customer could sue Sandy and Jeff and come after either’s personal assets.

That’s a lot of liability for every partner to shoulder, so many people opt for a limited liability partnership instead. In a limited liability partnership, partners are not personally liable for the debts and obligations of the business. Partners in an LLP can certainly lose their investments if the business doesn’t do well, but the personal assets of each partner are safe from creditors. In order to form a limited liability partnership, you need to register your business with the state.

There’s one other variation on a partnership called a limited partnership. A limited partnership has two types of partners—general and limited. General partners are personally liable for the actions of other partners and for the partnership’s debts. Limited partners invest in the company and are only liable up to the amount of their investments. Limited partnerships are popular among family-owned businesses and real estate developers.

A Deeper Dive Into Limited Liability Partnerships

Now that we’ve got the fundamentals out of the way, we can dig into the nitty-gritty of why a limited liability partnership is a good thing, why it’s a bad thing, and who uses them anyway.

Benefits of Limited Liability Partnerships

Let’s take a closer look at the biggest benefits of converting your business into a limited liability partnership.

Personal Liability Protection

The main point of a limited liability partnership is to protect each partner from the potential mistakes of the others. There’s no single general owner of the business—instead, each partner owns his or her share, and they distribute responsibilities accordingly. Your assets aren’t at stake if another partner gets sued for malpractice, for example.

Of course, that protection doesn’t extend to partnership assets, only to personal assets. If there’s a lawsuit, then the partnership’s assets get targeted instead of those belonging to individual partners.

If there’s a company called Bob, Bart, and Barry, LLP, the three owners are partners, but still distinct. For instance, if Barry gets sued for malpractice or someone raises a claim of negligence against Bart, then Bob’s and Bart’s house and car are still in the clear. The company might lose some money, and Barry could wind up personally liable for his breach of conduct, but Bob’s and Bart’s own assets remain separate from the business’s.

Tax Breaks

If you’re an owner of a C-corporation, your income gets double taxed–once through the corporation, and dividends get taxed again on your personal income tax return.

Partners of a limited liability partnership have it better—their cash only gets taxed once, when they fill out their income taxes. Business income and profits pass through to each partners’s personal tax return. This is called a pass-through entity.

Flexibility

A limited liability partnership is easy to financially structure—and restructure. Partners can come and go, the business can grow and shrink, and even the way a partner’s salary is decided can vary. Should a partner get a percentage of the company’s profits? Of its gross revenue? From one stream, or multiple, or from across the board?

The best way to calculate these will change from business to business, but having the option to change your company’s structure fairly without altering its business entity type can be a huge help. You can customize the way you want your LLP to be run by drafting a partnership agreement, which we’ll explain more in a bit.

Management Structure

Yes, a limited liability partnership is easy to structure… But it’s flexible in more ways than just finances. As we mentioned, partners can come and go—and carry with them clients and employees.

Going back to Bob, Bart, and Barry’s limited liability partnership: these three professionals decided to pool together their resources and share employees, s well as office space and supplies. They’re each saving money by working together, and making extra by exposing themselves to each other’s profits. Their partnership also deals with a larger number and wider range of customers, which promotes growth on a bigger scale.

Finally, the management structure of a limited liability partnership is just more streamlined than that of, say, a corporation. Rather than deferring to a board of directors or to stockholders, a limited liability partnership need only hold votes among its partners.

Drawbacks of Limited Liability Partnerships

It’s not all positive, though: limited liability partnerships come with disadvantages as well.

Not All Businesses Are Eligible

Fortunately, the biggest drawback of a limited liability partnership is that not everyone can register their business as one.

Unfortunately, that’s actually a very large negative. As it turns out, the rules behind who can form limited liability partnerships are quite narrow—though if you don’t fall into the select few eligible groups, then a limited liability partnership probably wouldn’t have been best for your business, anyways.

The laws regarding limited liability change from state to state—both what kinds of businesses can form a limited liability partnership and what that limited liability actually means vary across the country.

Limited liability partnerships are generally connected to firms of lawyers, accountants, architects, and similar profession types—and in fact, some states like New York, California, Oregon, and Nevada allow only certain professions to form a limited liability partnership, and no one else. This isn’t just a coincidence, though: these types of professions make the most sense in limited liability partnerships, while others might not.

Some states are also stricter than others when it comes to partner liability. Most states recognize partners as protected from obligations in contracts, torts, and more, though some only allow protection against negligence claims—Tennessee and West Virginia are two examples of states where partners in a limited liability partnership are especially exposed.

Finally, all these complications pile on top of each other when a limited liability partnership wants to work across state boundaries. Some states with more restrictive laws don’t recognize limited liability partnerships from other states. Others will recognize them, but only if they conform to those states’ rules. In fact, one state might consider a company to be a general partnership instead of a limited liability partnership—which could cause a lot of legal headaches, especially if a partner’s liability is brought into question.

To sum up: not everyone can form a limited liability partnership, not all states define limited liability the same way, and not all states recognize the limited liability partnerships of other states.

Inefficiency

So, your business qualifies for a limited liability partnership. What’s a drawback to actually practicing in one?

Some say that limited liability partnerships can potentially run less efficiently than other business entity types since there isn’t necessarily a single leader who makes the big decisions. All partners can legally act in a management capacity, which could lead to redundancies, conflicting directions, and wasted resources.

The way around this is simply to communicate clearly and often, but we know that’s easier said than done. If you focus on the partnership side of limited liability partnerships, and recognize that inefficiency can and will have a tangible negative impact on your business, then this downside shouldn’t be too hard to overcome.

Fees and Franchise Taxes

Finally, limited liability partnerships often have to pay registration fees and franchise taxes. This drawback might be major or minor—it depends on your business. It also varies from state to state, as you might expect by now.

We’ll go into how exactly you register as a limited liability partnership later on, but for now, just know that you’ll need to pay a yearly registration fee to your secretary of state. This might be a flat rate or a per-partner charge.

You also may need to pay a franchise tax, which limited liability corporations also pay, depending on your state of business.

And, last but not least, some states require that limited liability partnerships maintain a sum of cash on-hand as insurance against liability claims.

How to Form a Limited Liability Partnership

The exact registration process to form a limited liability partnership varies from state to state. All states, though, will ask you to follow these steps, so at least make sure you’ve read and understood them before moving on.

1. Make sure you’re eligible

Check out your state’s rules and regulations on limited liability partnerships to see whether your business is eligible or not. In many states, only business owners in professions that require a state license can establish an LLP. The states of New York, California, Oregon, and Nevada have particularly narrow restrictions on what sorts of professional services a limited liability partnership can offer. Be sure you can qualify before you spend time applying.

You’ll also need to add in “Limited Liability Partnership” or “LLP” to the end of your name, in order to indicate that you’re operating as such. For example, our old friends Bob, Bart, and Barry had no choice but to label their company “Bob, Bart, and Barry, LLP.”

3. Designate a registered agent

A registered agent is a person or company who agrees to accept legal papers and other documents on your business’s behalf. You should carefully choose this person because they are responsible for notifying you of any pending lawsuits against your business. While you can choose a partner to be a registered agent, it’s usually better to choose a business attorney or registered agent service.

4. Apply for business licenses

Make sure you’re up to date on your required business licenses and permits, depending on your type of business and the state you operate in. Some states, such as California, regulate businesses heavily, and most companies require a business license. Typically, your county or city’s business division is the best place to obtain more information.

5. File a certificate of limited liability partnership

The certificate of limited liability partnership legally allows your LLP to start operating. You must file this certificate with the state. This application usually requires your business’s name, address, the names and contact information for the partners, registered agent’s contact information, and other administrative details. You’ll face a minor filing fee of $50 to $100, as well.

After submitting the information, the state will process your filing and send you a stamped copy back to keep with your business records. LegalZoom can help you register your business as a limited liability partnership.

6. Draw up a partnership agreement

A partnership agreement, which is optional in most states but highly recommended, defines each partner’s responsibilities, their roles, and of course, their protected assets. The Limited Liability Partnership Agreement also lays out exactly what liability defenses each partner receives, and acts as insurance against personal asset seizing in case of a suit or something similar.

7. Check whether you need to purchase specific insurance plans

Limited liability partnerships with employees might need to purchase workers compensation insurance on behalf of their team. Business owners in licensed professions might also need to buy malpractice insurance.

8. Comply with other state regulations

By now, you should have met the primary state obligations for formation. On an ongoing basis, you might have to pay an annual franchise tax in some states. Also, it’s a good idea to open a business bank account and business credit card that you use exclusively for business purposes. This will help to preserve your limited liability protection.

9. Comply with federal regulations

In addition to your state’s requirements, the federal government also regulates business entities. For example, you’ll need to apply for your federal employer identification number (EIN) through the IRS. You might also have to pay federal payroll taxes if you employ workers.

Bottom Line on Limited Liability Partnerships

Limited liability partnerships combine flexibility for businesses with multiple owners, along with legal protection for each owner’s personal assets. If you’re entering into business with multiple owners, and especially if you’re in a licensed profession, you should seriously consider an LLP business structure. Following the steps outlined above should help you launch your LLP in no time.

Priyanka Prakash, JD

Priyanka Prakash is a senior contributing writer at Fundera, specializing in small business finance, credit, law, and insurance. She has a law degree from the University of Washington and a bachelor's degree from U.C. Berkeley in communications and political science. Priyanka's work has been featured in Inc., Fast Company, CNBC, and other top publications. Prior to joining Fundera, Priyanka was managing editor at a small business resource site and in-house counsel at a Y Combinator tech startup.
Email: priyanka@fundera.com.